Friday, August 31, 2007

As I had noted before, in 2004 new home sales exhibited an interesting phenomena whereby the distribution of home sales, grouped by several price ranges, effectively flipped from what one might conclude to be logical and from the historical norm.

Prior to 2004, in general, the least expensive new homes sold the most numbers of units while the most expensive new homes sold the least numbers of units.

Not a very surprising result as one might easily conclude that the majority of new home buyers cannot, in general, afford the most expensive homes.

After 2004 though, the scenario exactly flipped in that the most expensive new homes easily outsold the least expensive homes.

Now, this could either be explained by the inflating of home prices during the boom, easy availability of bloated loans, home buying patterns, or a little bit of all of these events but no matter what the cause, it appears that the scenario is now in the process of flipping yet again.

Since the peak in 2005 new home sales have been falling among all price ranges but more recently there have been relative strength in the sales of lower priced home and a marked weakness in sales of the highest priced homes.

The interesting point here is that the “flip” that occurred in 2004 was likely an anomaly made possible by the boom which is likely to completely reverse in the coming years as the environment for home building settles back to a more historically normal scenario.

This “re-flipping” of new home sales may serve as a good indicator of the unwinding of the boom.

The first chart shows new home sales for the highest priced new homes, i.e. homes priced above $300,000 (click for larger version). Notice that since 2005 sales have been declining sharply.

The following chart shows both a "smoothed" and raw unadjusted number of new homes sold for four different price ranges (click for larger). Notice that the price ranges appear to be converging and likely flipping back to a more historical normal pattern.

Another way to visualize this issue is to view each price ranges “market share” of all new homes sold (click for larger version). Notice that back in 1999, over 40% of new homes were priced under $200,000 whereas now, new home sales for homes in this price range total less than 20%.

Thursday, August 30, 2007

Today, the Bureau of Economic Analysis (BEA) released their second installment of the Q2 2007 GDP report showing higher than expected growth of 4.0%, buoyed by strength in nonresidential structures and federal, state and local government spending, a decline in imports while continuing to be weighed down by weakness to fixed residential investment.

It’s important to keep in mind that today’s results are still preliminary and will not be finalized until the next installment.

Residential fixed investment, that is, all investment made to construct or improve new and existing residential structures including multi–family units, continued its historic fall-off registering a decline of 11.6% since last quarter while shaving .61% from overall GDP.

Housing continues to be, by far, the most substantial single drag on GDP subtracting an amount roughly equivalent to the contributions made by all exports of goods during the quarter.

The most recent release of the S&P/Case-Shiller home price indices for June continued to show weakness for the nation’s housing markets with 15 of the 20 metro areas tracked reporting significant declines.

Topping the list of decliners on a year-over-year basis was Detroit at -11.01%, Tampa at -7.70%, San Diego at -7.30%, Washington DC at -6.96%, Phoenix at -6.55, Las Vegas at -5.09%, and Miami at -4.79%.

Additionally, both of the broad composite indices showed accelerating declines slumping -4.07% for the 10 city national index and -3.49% for the 20 city national index continuing the first negative slump in annualized appreciation seen since the early 90’s housing bust.

Additionally, in order to add some historical context to the perspective, I updated my “then and now” CSI charts that compare our current circumstances to the data seen during 90s housing decline.

To create the following annual charts I simply aligned the CSI data from the last month of positive year-over-year gains for both the current decline and the 90s housing bust and plotted the data with side-by-side columns (click for larger version).

What’s most interesting about this particular comparison is that it highlights how young the current housing decline is, having only posted four consecutive year-over-year (YOY) monthly declines to home prices.

Looking at the actual index values normalized and compared from the respective peaks, you can see that we are only ten months into a decline that, last cycle, lasted for roughly fifty four months during the last cycle (click the following chart for larger version).

The “peak” chart compares the percentage change, comparing monthly CSI values to the peak value seen just prior to the first declining month all the way through the downturn and the full recovery of home prices.

In this way, this chart captures ALL months of the downturn from the peak to trough to peak again.

As you can see the last downturn lasted 97 months (over 8 years) peak to peak including roughly 43 months of annual price declines during the heart of the downturn.

Notice that peak declines have been FAR more significant to date and, keeping in mind that our current run-up was many times more magnificent than the 80s-90s run-up, it is not inconceivable that current decline will run deeper and last longer.

Wednesday, August 29, 2007

Since when did holding a Bullish outlook mean that you lost all sense to recognize even the most obvious trend?

This whole housing decline has, unfortunately, been a very divisive issue with the typical dichotomy of a line in the sand and a camp (or camps) on either side.

Be they “Bulls” vs. “Bears”, “Housing Heads” vs. “Bubble Heads”, or “Mortgage Debtors” vs. “Angry Renters”, the housing decline has sparked endless heated debates with numerous justifications on either side for either optimism or pessimism.

Yet, at this point, there has got to be hardly a single argument against the notion that the nation’s housing markets are in tough shape.

One only needs to look at the continued declines to home sales and prices, the historic levels of inventory of available homes, as well as the latest events in the mortgage-credit markets to see that things are broadly bad.

Furthermore, taking a minute to pause and reflect on the somewhat circuitous route that the Bull-Bear debate has taken both corroborates the more accurate outlook as well as helps to dispel any hopes of a purported imminent bottoming and recovery of the housing market.

Back in 2005, any person (even reputable and notable economists) that even hinted at the idea that the housing boom was an irrational mania was sure to be labeled as a “Chicken Little”.

In 2006, we all had a much needed dose of reality but Bulls continued to downplay the severity of the turn in the housing cycle, preferring instead to handicap the arrival of the “soon-to-be” bottom.

This inability to accept the obvious resulted in at least two very widely reported yet wholly inaccurate instances of consensus amongst those of the Bullish persuasion, that the markets had, in fact, bottomed (once in September of 2006 and then again in February of 2007).

Now, almost two years after the first cracks started showing up in the housing mania and with what has been termed by the Federal Reserve as a “crisis” in the mortgage and financial markets, Bulls continue to remain exuberantly hopeful that the turnaround is on the way.

While refusing to acknowledge even the possibility of “spillover” effects on to the generally economy, even in light of the recent, clearly correlated, declines in retail sales as well as some highly publicized downward revisions to earnings guidance from notable national retailers, Bulls simply continue the trend that has served them so poorly.

Looking back at past housing busts it’s easy to see that, although the current bust is more widespread and many times more significant than past declines, it’s following a fairly typical course.

If things roughly follow along as they have in past busts, then we are in the very early stages of a “correction” that will, at the very least, be many years in the making and carry with it many of the same trials.

We have yet to see the complete effects caused by some of the most significant elements of fallout from this decline including the full brunt of the mortgage resets, higher interest rates and lower availability of mortgage debt, particularly Jumbo loans, and the effects of prolonged oversupply and accelerating price declines.

There is not a doubt in my mind that many years from now, the bust of this cycle will appear so obvious that it will be dumbfounding to recall that there was even a single spectator who actually believed that a “V”-shaped turnaround was always right around the next corner or that the health of the general economy was not in peril.

The Mortgage Bankers Association (MBA) publishes a weekly applications survey that covers roughly 50 percent of all residential mortgage originations and tracks the average interest rate for 30 year and 15 year fixed rate mortgages as well as application volume for both purchase and refinance applications.

The purchase application index has been highlighted as a particularly important data series as it very broadly captures the demand side of residential real estate for both new and existing home purchases.

The latest data is showing that the average rate for a 30 year fixed rate mortgage decreased marginally since last week and now stands at the near peak for the year at 6.41% while the purchase volume decreased 4.0% and the refinance volume decreased 4.2% compared to last weeks results.

It’s important to note that the data is reported (and charted) weekly and that the rate data represents average interest rates, and the index data represents mortgage loan application volume for home purchases, home refinances and a composite of all loans.

The following chart shows how the principle and interest cost and estimated annual income required to cover the PITI (using the 29% “rule of thumb”) on a $400,000 loan has changed since January 2007.

The following chart shows the average interest rate for 30 year and 15 year fixed rate mortgages over the last number of weeks (click for larger version).

The following charts show the Purchase Index, Refinance Index and Market Composite Index since January 2007 (click for larger versions).

Senior Economist Lawrence Yun is now suggesting that the weakness, if it were not for the mortgage-credit meltdown, home sales would “probably” be rising.

“Home sales probably would be rising in the absence of the mortgage liquidity issues of the past two months, … Some buyers with contracts have been scrambling when loan commitments did not materialize at the last moment, while other potential buyers are simply waiting for the mortgage market to stabilize.”

“For buyers able to qualify for conventional financing, there are ample opportunities in the current market, … Availability and pricing of conventional loans are reasonable, and FHA-insured mortgage applications have been rising as low- and moderate-income buyers seek alternatives to subprime loans. If buyers are in it for the long haul, now can be a good time to get into your home.”

Looking at July’s Existing Home Sales report should only result in additional confirmation that the nation’s housing markets are continuing to experience weakness with EVERY region showing considerable declines to sales of BOTH single family and condos as well as significant increases to inventory and monthly supply.

Keep in mind that we are now seeing existing home sales declines on the back of last years fairly dramatic declines further indicating that the housing markets are not bottoming as many had been suggested last fall.

Below is a chart consolidating all the year-over-year changes reported by NAR in their July 2007 report.

Particularly notable are the following:

Sales are down significantly in EVERY region and for BOTH single family and condo.

ALL Inventory and Months Supply show significant increases on a year-over-year basis.

Sunday, August 26, 2007

“Silent life of crimeA man of odd circumstance,A victim of ghetto demands.Feed me money for styleAnd I'll let you trip for a while.Insecure from the past,How long can a good thing last?

Got to be mellow, y'allGot to get mellow, nowPusherman gettin' mellow, y'all

Heavy mind, every signMakin' money all the timeMy LD and just meFor all junkies to seeGhetto Prince is my thingMakin' love's how I swingI'm your Pusherman” – Curtis Mayfield

You have to admit, Chairman Bernanke is pretty cool…

The commercial paper market stalls… “ain’t no thang”… Here’s $30 billion… just pay it back when you can…

Financial markets continue to stumble as Wall Street “junkies”, strung out on yield and leverage, writhe desperately for their next hit… Bernanke’s “discount” window is open for business and he don’t mind your crap collateral.

Friday, August 24, 2007

It was brought to my attention earlier this week that by using the term “PaperMoney”, a duly reserved and registered service mark, I have been inadvertently infringing on the rights of its owner.

I can assure all my readers, as I have the owner, that I had no prior knowledge of the existence of an online eZine-style website baring the same name and that, had I known, I would have not chosen to use this term.

In order to remedy this situation and as a sign of respect and goodwill for the owner who registered this term long ago and has maintained continuous use ever since, I am today formally changing the name of this blog to PaperEconomy.

I am disappointed, to say the least, as the term PaperMoney was, to me, a perfect representation of my current sentiment and outlook for housing and the economy in general.

In fact, it literally occurred to me instantaneously when I decided to start my own blog on the housing bubble.

I felt it was just the right way of suggesting the ephemeral nature of unrealized wealth, a notion that seemed to suit the state of housing particularly well.

Maybe it was a bit snarky, but over the last 16 months I have grown to really see it has my own as I have with the blog itself.

Oh well… you can’t have everything.

To that end, the new name, PaperEconomy, is not too shabby either!

It’s reminiscent of the prior name and even seems to broaden the original message a bit…

As in:

“…at first I thought it was strong and resilient, then I realized it was a Paper Economy! (like Paper Tiger maybe?)”

Or even:

“…this whole dammed economy is propped up on paper!”

Well, that might be a bit over the top but you get the picture.

The key point here is that neither the blogger nor the blog has changed… just the title.

So keep reading, we have a long long way to go in the housing decline and the story is only just beginning to heat up!

Today, the U.S. Census Department released its monthly New Residential Home Sales Report for July that, despite all the traditional media’s “unexpected increase” coverage, continues to show weakness as well as significant downward revisions to April and May’s results.

As with prior months, on a year-over-year basis sales are still declining significantly at 10.2% below the sales activity seen in July 2006.

It’s important to keep in mind that these declines are coming on the back of the significant declines seen in 2006 further indicating that housing bust is significant.

The following charts show the extent of sales declines seen since 2006 as well as illustrating the further declines 2007 is showing on top of the 2006 results (click for larger versions)

Note that the last chart essentially combines the year-over-year changes seen in 2005 and 2006 and shows sales trending down precipitously as compared to the peak period.

Look at the following summary of today’s report:

National

The median price for a new home was up .58% as compared to July 2006.

New home sales were down 10.2% as compared to July 2006.

The inventory of new homes for sale declined 7.0% as compared to July 2006.

The number of months’ supply of the new homes has increased 1.4% as compared to July 2006.

Regional

In the Northeast, new home sales were down 11.7% as compared to July 2006.

In the West, new home sales were down 19.6% as compared to July 2006.

In the South, new home sales were down 3.0% as compared to July 2006.

In the Midwest, new home sales were down 18.2% as compared to July 2006.

Thursday, August 23, 2007

This one is clearly in the “a picture says a thousand words” category.

The following image (click for much larger version) is a series of underwriting guideline matrices for a famous, nationwide lender that was published back on March 5 but I have marked it up to make it current based in the most recent sheet published August 20.

The items NOT crossed out are what are left for possible loan production!

There has been a lot of discussion lately on whether, by moving too aggressively in shoring-up the market, the latest actions by the Federal Reserve constitute a “moral hazard” which inadvertently conveys to market participants a false sense of security and even impunity leading, ultimately, to inefficient behavior and careless risk taking.

Yet, given the policies of the Fed in recent times, it’s seems hard to differentiate the measures taken by “helicopter” Ben from the former “easy money” maestro in order to determine which era might be deemed hazard causing and which not.

I suppose the best way to judge is simply to watch the sentiment and actions of the market participants themselves to see if they appear to be relying on presumed assurances from a higher power when making their market bets.

It’s subtle so I’ll give you a hint… the part towards the end of the clip where, surrounded by a large cadre of Wall Street goons, Ratigan, in a crescendo building cheerleading tone, states “Five days in a row… this markets been higher. You can thank the Federal Reserve for that. Ever since they stepped in this market has been [up up and?] away.”

So I guess the hazard is on, where it ends only time will tell but let’s just hope that it’s not with Bernanke hurling sacks of cash from the General Lee.

Possibly the old TV serial lyric holds a clue:

“Straightening the curves, flattening the hillsWell someday the mountain might get 'em but the law never will

Just two good ol' boys, wouldn't change if they couldThey're fighting the system like two modern-day Robin Hoods”

Oh well… it’s just the economy…. By the way, I’m the spitting image of Cooter.

Yesterday, Toll Brothers (NYSE:TOL) reported Q3 earnings results confirming an additional $147.3 million of pretax write-downs that helped to depress their net income by an astounding 84.82% as compared to Q3 2006.

Also, it's important to note that the company has now announced a total of $363.9 million in pretax write-downs thus far in 2007 in a year that, in December of 2006, they had anticipated at most $60 million.

During the conference call, CEO Bob Toll appeared to offer very little optimistic sentiment pointing out that “horrible” buyer traffic is and setting new lows, handily surpassing the lows of prior downturns.

Additionally, Doug “The Bear” Kass of Seebreze Partners Management, Inc. makes an interesting appearance toward the end of the call.

The following are excerpts from yesterday’s conference call:

When asked about his “F- -“ rating for the Las Vegas housing market Toll replied:

“You might add another minus to that… What does it mean? It means you’ve flunked and what are we doing about it? We’re out there with the rest of the builders in Vegas praying. There’s not much you can do… You can’t advertise your way out of that situation. You just have to wait for a market to come back.”

Then referring to the results of the entire operations in Las Vegas, Toll reported:

“This week we took no deposits… we did take one agreement. Last week we took five deposits… the week before that we took none. The week before that we took six… The preceding four weeks before that we took twelve. These are deposits… I would guess about two thirds go to agreement. Then some of the agreements don’t stick. In the last eight weeks we’ve taken seven agreements. So, that’s what we consider real bad.”

When asked about whether buyer traffic was down in August as the mortgage-credit meltdown issue heated up Toll responded:

“Very simply, traffic is horrible. This past week was the lowest traffic for this particular week ever in our history. And that condition has existed, pretty much, for the last nine weeks. And then prior to that, there was a little hiatus where we did a little better that the worst in our history… then going back a little further, once again we are doing the worst in our history. So, our history includes ’87, ’88, ’89, ’90 so traffic is pretty stinky out there. ”

The final “piece de resistance” of the conference call was delivered by none other than Doug “The Bear” Kass of Seabreeze Partners Management, Inc.

Kass asked “This is a much broader question than has been asked on the conference call…(Toll: It’s great to be a short by the way… Kass: chuckles…) If the administration came to you to resolve the housing crisis, what remedies would you recommend Bob to bring supply and demand back into balance over a reasonable period of time?”

“Well, I think the most important thing is to immediately address the mortgage concerns. Giuliani was asked in an interview with Kudlow recently… would he bring in any regulation and he said that it was up to the market to straighten things out and it will. In my opinion, that’s probably what the guys said in ’29 that were running the Fed.

I was castigated recently for suggesting a few weeks ago that some government regulation would not be a bad thing. The average reaction was, the minute you let the government in, you’re begging for disaster. I can generally agree with that, look at whats happened with wetland regulations for instance… you need a team of lawyers to fill a puddle in your back yard.

On the other hand, where would we be without anti-trust legislation? We would probably have one oil company known as the United States of American Standard…. (chuckles about the slipup… American standard is a toilet manufacturer Toll was referring to Standard Oil)

I think a little regulation wouldn’t be a bad thing. I wouldn’t rule out 100% or 90% LTV but if you’re seeking that kind of thing, you have to pledge additional assets or at least prove additional assets so that so if the home price goes down and you want to walk, the mortgage lender has got a note that he can apply not only to the home but that he can apply to other assets that are obviously sufficient to take care of the loss.

What happened was, for a hundred years we had S&L’s as the backbone of the mortgage system and then they went bad and we tossed the baby out with the bathwater. And went to another system, that I don’t suggest that we try to break away from which is the securitization.

The problem is, everybody is working on commission today, nobody is a portfolio lender.

The guy that wants to get you the mortgage is a commission fella, and he’s handing it over to guys that are working commission to package it. The brokers are working on commission in order to sell the goods. And the guys buying the goods are not really paying attention to what they’re buying. And I think it’s reasonable to have standards imposed that you can’t lend above these lines and that should, to some extent, protect us from ourselves.

But I’m getting so many ‘cut the throats’ around here… guys are signaling to me to please stop this… and remember this is a Toll Brothers call and not a Bob Toll call so I’m off, I’m going back to Toll Brothers.”

Keep in mind though, a 6% jump from last July is not saying very much as the result is still at the slowest pace of sales for a July since 1995.

Also, The Warren Group, which records much more comprehensive sales and median price figures based off of actual deed transactions, reported results that are more consistent with the latest results of the S&P/Case-Shiller home price index for Boston showing a more tame 1.5% increase in single family home sales with a 4.6% drop to the median home price.

But since we all know MARs results are skewed by MLS only listings and we have been following them all along, let’s just play along for the moment.

Possibly in a future post I’ll throw out the MAR numbers altogether and switch over the obviously more accurate Warren Group figures.

Along with MARs release, President Doug Azarian continued to spin his optimistic tales suggesting the buyers with “good credit” are back “buying again”.

“While the tighter lending standards may have taken some buyers out of the market over the past several months, it appears that those who have good credit and some equity, are getting the financing they need and are buying again.”

Azarian forgets to mention that buyers are buying like they are in 1995!

Mmmm… What a frenzy!

An important figure in today’s report though is the single family inventory and monthly supply which, while still showing overall inventory declining, shows demand slowing even faster resulting in an 8.6 month supply of homes, a 15% increase compared to last month.

Again, as I noted last month, June, July and August typically show the highest volume of sales for the year (see the chart below and click for larger version) so calculating the months supply from these months sales pace is a bit unrealistic.

Possibly a better choice would have been to simply average the monthly sales results seen in to date in 2007 and use that as the denominator.

This would yield an average of 3591 single family home sales per month resulting in a likely more accurate 10.3 “months of supply” of single family homes.

Also note that as seen in the chart above, home sales are continuing to weaken with 2007 results generally coming in below 2006 which were generally below the results seen in 2005.

As for home prices, MAR reports a increase of 1.3% to the median price for a single family home as compared to July 2006 while the Warren Group again reported a more significant, and likely more accurate, drop of 4.6%.

With significantly falling prices, continued declining sales volume and a slowing pace of sales, it seems hard to believe that Azarian’s “encouraging signs” call and optimistic outlook has any merit especially when considering that all of this weakness is coming on the back of the historic declines seen in 2006.

A more likely scenario is that our area is experiencing a fundamental correction to prices that, through unusually low interest rates and historically easy lending standards, were able to rocket to irrational heights during the run-up years.

To better illustrate the drop-off in home prices and the potential length and depth of the current housing decline, I have compared BOTH the year-over-year and peak percentage changes to the S&P/Case-Shiller home price index for Boston (BOXR) from the 80s-90s housing bust to today’s bust (ultra-hat tip to the great Massachusetts Housing Blog for the concept).

The “year-over-year” chart compares the percentage change, on a year-over-year basis, to the BOXR from the last positive value through the decline to the first positive value at the end of the decline.

In this way, this chart captures only the months that showed monthly “annual declines” and as we can see, if history is to be a guide, we could be about one third of the way through the annual price declines with the majority of falling prices yet to come.

The “peak” chart compares the percentage change, comparing monthly BOXR values to the peak value seen just prior to the first declining month all the way through the downturn and the full recovery of home prices.

In this way, this chart captures ALL months of the downturn from the peak to trough to peak again.

As you can see the last downturn lasted 105 months (almost 9 years) peak to peak including 34 months of annual price declines during the heart of the downturn.

Notice that peak declines have been more significant to date and, keeping in mind that our current run-up was many times more magnificent than the 80s-90s run-up, it is not inconceivable that current decline will run deeper and last longer.

As in months past, be on the lookout for the inflation adjusted charts produced by BostonBubble.com for an even more accurate "real" view of the current market trend.

July’s Key Statistics:

Single family sales increased 6.0% as compared to July 2006

Single family median price increased 1.3% as compared to July 2006

Condo sales declined 0.1% as compared to July 2006

Condo median price increased 6.3% as compared to July 2006

The number of months supply of single family homes stands at 8.6 months.

The number of months supply of condos stands at 8.6 months.

The average “days on market” for single family homes stands at 123 days.

I can't think of a more preposterous and irrational example of exuberant upside bias on the part of the Federal government then that of the recent toiling over the OFHEO conforming loan limit.

For those of you that are not yet familiar, the Office of Federal Housing Oversight (OFHEO) is the government agency that is responsible for regulating the two primary Government Sponsored Enterprise (GSE) mortgage giants, Fannie Mae and Freddie Mac.

One of the main, if not THE main, role of OFHEO is to set the “conforming loan limit”, a maximum loan value that is used to act as the threshold between a “safe” loan that Freddie Mac and Fannie Mae are allowed to purchase and an “unsafe and unsound” loan “running contrary to statute”.

This is how the “conforming” vs. “Jumbo” loan is defined… below the limit is “conforming” above is non-agency “Jumbo”.

Currently, the limit for a single family home is $417,000, pretty frothy when you consider that, only as far back as 2000, the limit stood at $252,700.

Keep in mind that this means that an average home buyer can go to a mortgage broker, bank or other lender and borrow as much as $417,000 of home loan principle and still remain eligible for GSE underwriting that carries a lower rate of interest since GSE loans are assumed to be backed by the full faith and credit of the federal government (this assumption is really a bit of a myth… but that’s a post for another day when things really start to quake!).

So how is it, you ask, that the limit nearly doubled in roughly 5 years (keep in mind, it was set to $417,000 in November 2005)?

Easy, when the home prices went up, they simply raised the value (for more detailed information on how they change the limit, see my prior post on the subject).

But now comes the sticky part… now that home prices are going down, what are they doing to the limit?

The answer is surprise… OFHEO is coming up with all sorts of oddball ways of keeping from having to lower the limit (see my pasttwo posts on the subject)

In fact, in 2006 when home prices declined which, according to their prior inflating methodology, should have resulted in a reduction of the conforming loan limit, OFHEO revised their guidelines and left the limit unchanged.

Now in 2007, home prices are going to fall again, only this time by a likely far more significant percentage and what has OFHEO done in response?

They have revised the guidelines once again, effectively postponing any decrease until certain conditions are met (again, see my prior post on the subject).

After soliciting public comment in June and July about the proposed changes to the guidelines, OFHEO received a number of respondents, particularly the National Association of Realtors (NAR), the National Association of Home Builders (NAHB) and the Mortgage Bankers Association (MBA) as well as Fannie Mae, Freddie Mac and a whole raft of two-bit mortgage lenders who expressed clear opposition to the changes NOT because they would leave the limit unchanged BUT because they feel OFHEO should NEVER LOWER THE LIMIT!

ONLY UP... NEVER DOWN!

If that weren’t outrageous enough, there has been much talk for the last few days coming from Congressional figures such as Representative Barney Frank (D-MA), the Chairman of the House Financial Services Committee, who actually prefers that the limit be INCREASED, even in the face of two years falling home prices!

The point of this, obviously, would be simply to force Fannie and Freddie to effectively “re-liquefy” the now totally stalled Jumbo market.

Apparently though, both Treasury Secretary Paulson, and Senate Banking Chairman Dodd (D-CT) have expressed that it will take specific legislative action in order to allow OFHEO to raise the conforming limit above the current level.

Now, I’m not very sure why they have concluded this as OFHEO just modified its procedures for lowering the value without any legislative debate whatsoever, but it really makes no difference.

If you listen closely to Dodd, Frank and Paulson, they are all saying the same thing namely it will take legislative action and the legislation is on the way.

This is one of the most egregious examples of a dimwitted Congressional-Federal assault on the “free” markets I have ever seen.

They, in the supposed well meaning attempt to help “average” Americans, are essentially attempting to control the market price of residential real estate.

Don’t underestimate the severity of this fumbling.

To put it in better perspective, it has recently been estimated (in Dean Bakers latest excellent paper... hat-tip HousingPanic) that there is anywhere between $4 to $8 TRILLION of housing equity that will be lost in the process of deflating (re-pricing) the housing bubble, bringing prices back to hundred year historical averages.

This means the by finagling with things like the conforming loan limit, mortgage bailout funds and foreclosure timeouts, the Federal government is attempting to use both taxpayer dollars and the full faith and credit of our government in order to maintain absurdly inflated housing values and the artificial wealth this boom created.

This would clearly create a moral hazard of unparalleled proportions.

Remember, Jumbo loans were most frequently used by upper middle class affluent home buyers, and for the ones that are now in trouble, the ride down will be painful.

But that is the price you pay for taking a risk in a “free” market.And who better to take this hit than Americans with generally good incomes and employment opportunities.

If the government is smart it will allow this natural correction to take place unfettered, permitting scores of Americans to learn a valuable life lesson.

The Mortgage Bankers Association (MBA) publishes a weekly applications survey that covers roughly 50 percent of all residential mortgage originations and tracks the average interest rate for 30 year and 15 year fixed rate mortgages as well as application volume for both purchase and refinance applications.

The purchase application index has been highlighted as a particularly important data series as it very broadly captures the demand side of residential real estate for both new and existing home purchases.

The latest data is showing that the average rate for a 30 year fixed rate mortgage increasing marginally since last week and now stands at the near peak for the year at 6.49% while the purchase volume decreased 5.0% and the refinance volume decreased 6.4% compared to last weeks results.

It’s important to note that the data is reported (and charted) weekly and that the rate data represents average interest rates, and the index data represents mortgage loan application volume for home purchases, home refinances and a composite of all loans.

The following chart shows how the principle and interest cost and estimated annual income required to cover the PITI (using the 29% “rule of thumb”) on a $400,000 loan has changed since January 2007.

The following chart shows the average interest rate for 30 year and 15 year fixed rate mortgages over the last number of weeks (click for larger version).

The following charts show the Purchase Index, Refinance Index and Market Composite Index since January 2007 (click for larger versions).

To add a further complexity, Congress is now stepping up its actions, announcing a previously unscheduled meeting today between current presidential candidate and Senate Banking Committee Chairman Senator Dodd (D-CT) and Ben Bernanke as well as a seeing a significant new round of regulatory rumblings from House Financial Services Committee Chairman Representative Barney Frank (D-MA).

Finally, as Nouriel Roubini sees it, the Feds latest strategy has not worked, panic is continuing to spread as indicated by the by the latest US Treasury yields, and that the Fed is likely to cut rates 25 basis points in September and possibly could have an emergency cut even earlier.

Monday, August 20, 2007

I’m guessing that this must be a confusing time to be a central banker, what with the “appreciable downside risks to growth” and all.

One day your economy seems “likely to continue expanding at a moderate pace supported by solid growth in employment and incomes”, the next… you’re trying to “facilitate the orderly functioning of financial markets”.

I don’t envy these folks.

Imagine having the responsibility of helping to guide the world’s largest economy through the ups and downs of economic cycles.

Analyzing indicators, conferring with other Reserve members, more analyzing… All the uncertainty…

There must be times when you just feel like throwing darts!

Why not?

Some component of anyone’s future outlook has to be a hunch right? Well, maybe that’s how we got into this mess in the first place.

Either way, central banker or not, we’re all human and as such, subject to certain biases in our perception.

Whether it’s misinterpreting the implications of this month’s industrial production figures or simply charging another jet ski to your vacation home’s HELOC (you know, the one that still has some room on it), mistakes are made and usually faulty insight is to blame.

I hate to say it, but I think sometimes an “Achilles Heel” of being a central banker appears to lay in both being likely very affluent as well as holding a great degree of skill and willingness to digest the economy’s macroeconomic statistics when drawing conclusions.

Don’t get me wrong, you all know I love statistics, but I think this particular combination of attributes may leave a central banker detached a bit from what the ordinary person experiences making them more academic and possibly resulting in a lot of misguided assumptions.

It seems to draw the right conclusions, namely, that, as a direct result of financial innovations in the mortgage market and the housing boom, household debt (as a ratio of income) is higher than it’s ever been in history (and consequently the personal savings rate is at the lowest point) leaving many Americans more vulnerable to various economic shocks.

But yet, throughout the paper little bits and pieces seem to reveal an unrealistic bias towards rational action leaving the reader wondering what world Kohn is working in.

For example, witness this passage:

“In a (hypothetical) world with no borrowing constraints, households choose a path for consumption based on their expected lifetime resources, interest rates, and tastes. … Households also choose their portfolio allocation, determining the amounts they hold of different types of assets and liabilities consistent with their net worth.”

Instead, how about the following for a more realistic view:

In a world with no borrowing constraints, people borrow to the hilt, competitively buying as much of anything they desire, especially McMansions and eventually, after getting completely tapped out, pray desperately that they don’t lose they’re job.”

Here’s another doozy from Kohn’s paper:

“… an increase in house prices changes the composition of household portfolios and may induce portfolio rebalancing that involves increases in debt holding. In particular, households may borrow against their house to invest more in tax-deferred retirement assets.”

How about this instead:

“… an increase in house prices changes the composition of the things inside the house, particularly effecting consumer electronic devices, granite countertops, stainless steel appliances, whirlpool baths, and every manner of luxury food, beverage and tobacco item you can imagine.”

The paper goes on from there taking great pains to describe in vivid detail what for the most part is fairly obvious to most, concluding with, among other things, this seemingly sound assessment:

“The most important factors behind the rise in debt and the associated decline in saving out of current income have probably been the combination of increasing house prices and financial innovation.”

Unfortunately though, Kohn then closes with this sad bit of analysis:

“Although higher debt service obligations relative to income would appear to leave households more open to unexpected changes in income and interest rates, many macroeconomic shocks involve the demand for goods and services and tend to lead to offsetting movements in income and interest rates. Moreover, the increase in access to credit and levels of assets over time should give households, on average, a greater ability to smooth through any shocks.”

So, when the economy tanks, interest rates will come down and all the cash-strapped households will simply live to borrow another day…

Friday, August 17, 2007

I hate to belabor this point but I really think that the vanishing of the affordable prime Jumbo loan is easily the most significant development for home prices that I have heard all year.

Remember, the Jumbos have dried up for PRIME borrowers.

But what does it mean to say “dried up”… again, as I noted before, it simply means borrowers will need to put 20% down (or have 20% equity for refinance), provide full disclosures of income (tax returns, stubs, etc.) and then pay over 7.5%.

This appears to have happened merely because Wall Street, who inevitably supplied the liquidity behind these loans, are now obviously more risk averse and are effectively unwilling to cheaply underwrite large home loans.

And the cheap Jumbos are not coming back anytime soon.

Why?

These loans are for the most qualified borrowers at the higher end of the income spectrum so you have to ask yourself… what is wrong with affluent borrowers being required to put 20% down, verify income, and pay a premium for a large principle loan?

The key point here is that the terms have just come back to normal… NOT tightened!

Also, remember that, unlike the subprime issue, there is not even the slightest chance that any government program, Fannie, Freddie, FHA, VA, etc. or for that matter any politician can do or will do ANYTHING about it.

People who currently have rate-resetting large principle loans or are planning to get one for a new purchase are on their own.

Again why is this important?

Because, in the last 5 years (really the last 10 years in the ultra-hot bubble metro markets) it’s NOT been the Vanderbilt’s who have been making use of Jumbo loans… it’s been the middle class dual income couple (DINKS and with kids) and the upper middle class professional individual.

The out of control spiraling buying mania forced virtually everyone in the bubble metro’s to stretch ever higher for the brass ring of the coveted residential property.

Whether it was for a starter single family, rehabbed single, simple or luxury condo, affordable Jumbos with low down payments were a KEY element in enabling the prime home buyer to function in these areas.

This is the major shoe to drop for the ultra-inflated home prices in this cycle.

As for today’s Fed discount rate cut… Don’t look for that kind of Federal Reserve action to restore the easy lending days of the past.

At this point, lenders, banks and Wall Street alike are merely concerned with how to stabilize their operations, preserve capital and stay solvent NOT how to maximize profits by ignoring risk.

Thursday, August 16, 2007

Bloomberg today reports that in order for Countrywide Financial (NYSE:CFC) to continue its loan operations it has had to tap $11.5 billion of what it states is a $185 billion (CORRECTION: apparently at some point today it was reported that the $11.5 billion was Countrywide's ENTIRE credit line... so the $185 figure is false) in available credit lines.

To put the company’s current predicament into perspective a bit, for the month of July Countrywide reported that it had an average daily loan activity of $2.7 billion, so they have effectively bought themselves 4.25 days of operations at that level.

To be fair, this would assume that the company is completely stalled and that the $11.5 billion would be used to fund 100% of their daily loan production which is likely not the case.

In any event, it seems paltry to me and given that it was reported that they used 40 different banks for the sources of the funds, it’s quite possible the $11.5 billion was all they could get at the moment.

As the Bloomberg article points out… look for Countrywide to ask the Fed for a handout in the near future… although that relationship may possibly have been damaged by the company’s recent conversion to a savings and loan in order to get out from under the Federal Reserve’s regulation.

One week the Bulls are celebrating the “Goldilocks Economy” and DOW 14000 the next, a worried crisis-laden Larry Kudlow is stammering kookily about some crazy idea that the Federal Reserve should be buying up all the subprime and jumbo mortgages in order to prevent financial collapse… and in front of Robert Shiller no less!

Among the tumult surrounding Countrywide Financial and other mortgage lenders, yesterday’s business media was peppered with a slightly new and possibly more significant source of trouble for the nation’s housing markets, particularly for the hyper-inflated ultra-bubbly metro areas.

The availability of “Jumbo” mortgages, i.e. mortgages that exceeded the current OFHEO limit for Freddie Mac and Fannie Mae conforming loan status (currently $417,000 for a single family home), have essentially ground to a halt.

I say essentially because you can still get a Jumbo loan provided you give full documentation of your income (tax returns, pay stubs etc.), put down 20% on the purchase and are willing and able to finance the remaining principle at an over 7% interest rate.

Use Bankrate.com now and see for yourself… fixed rate, ARM, Interest Only… it doesn’t matter they are virtually all over 7% and almost non-existent if you’re not putting down 20%.

This is a kiss of death for the bubble-metro areas where home prices, even for the most modest starter homes, are still ridiculously inflated after having been pumped up by years of a loose lending induced buying mania.

The availability of cheap Jumbo’s is absolutely necessary for these areas to maintain any volume and fluidity of home sales, now they are gone and the first signs of the impact should be seen in the home sales statistics compiled during the next several months.

We have definitely reached another major turning point in the housing meltdown story as this will likely be the start of the most significant period of downward price adjustment in this cycle.

But wont things just snap back if the Fed cuts rates?

Not in my estimate.

To use an analogy, the mortgage meltdown is like an avalanche.

Friction exceeded its critical limit and the whole of the market has come crashing down the mountain.

Some lenders were instantly killed as pieces of debris crashed through their midsections; others are buried out of sight deep within the pile and, struggle as they might, will simply suffocate before they are able to resurface.

Still others are stuck in various ways but will go so far as to gnaw off arms and legs and stumble, bloody and hemorrhaging down to safety and a possible handicapped recovery.

A lucky few are simply trapped in shallow caves whereby, through a lot of digging, they will eventually free themselves, relatively unscathed but still bruised and shaken.

All the dead and survivors will share one thing in common though… none will be returning up the hill for some time to come.

P.S. I thought I might use another natural disaster analogy but with the earthquake in Lima Peru, a Tsunami threat in the Pacific, Hurricane Flossie hitting Hawaii, and tropical storms Erin in the Gulf and Dean in the Caribbean, I thought it might be in better taste to choose the avalanche!

Today’s New Residential Construction Report continues to indicate horrendous weakness in the nation’s housing markets and for residential construction showing substantial declines on a year-over-year basis to single family permits both nationally and across every region.

Single family housing permits, the reports most leading of indicators, again suggests extensive weakness in future construction activity dropping 24.0% nationally as compared to July 2006.

Moreover, every region showed high double digit declines to permits with the West declining 20.4%, the South declining 27.8%, the Midwest declining 22.3% and the Northeast declining 11.3%.

Keep in mind that these declines are coming on the back of last year’s record declines.

To illustrate the extent to which permits and starts have declined, I have created the following charts (click for larger versions) that show the percentage changes of the current values compared to the peak years of 2004 and 2005.

Notice that on each chart the line is essentially combining the year-over-year changes seen in 2005 and 2006 and shows virtually every measure trending down precipitously.

Although year-over-year declines to permits, for example, have not accelerated measurably from September 2006, the fact that they continue to decline roughly 20%-30% should provide a solid indication that they are by no means stabilizing.

Remember that permits, starts, and competitions are not simply independent measures but are, in fact, three logically related and dependent measures.

In the process of a building project, first you get the “permit”, next you “start” building, and finally you “complete” the project.

For this reason, one must adjust expectations prior to reading a newly released Census Department report to account for the true nature of the data published simultaneously each month.